Parties to merger and acquisition (“M&A”) agreements are now closely reviewing their contracts following the disruption caused by the pandemic.[1] In particular, parties are looking at their Material Adverse Change Clause (“MAC”) (also called Material Adverse Effect (“MAE”)) in contracts to analyze their options.[2] A MAC clause is a legal mechanism that permits the buyer to avoid closing the deal “if a material change has occurred in the financial condition, assets, liabilities, business, or operations of the target firm.”[3] Although typical MAC provisions have remained vague, MACs are among the most heavily negotiated nonprice terms.[4] However, following the economic shock of 9/11 and the financial crisis of 2008, “commentators have urged greater precision in the language of MACs.”[5] They argue that vague contract terms invite conflicting interpretations, which “fuel disputes, as well as costly and uncertain litigation.”[6] Today, following the effects of the pandemic, dealmakers negotiating MAC clauses are once again in the position to consider the uncertainties of both vague and precise terms.
Historically, Delaware courts have been exceedingly reluctant to allow buyers to invoke MAC clauses to escape from M&A deals.[7] Such claims typically face significant hurdles, with the acquirer bearing a “heavy burden” to establish the existence of a MAC.[8] In the Delaware Chancery Court, the burden is so heavy that there has only been one case where the court found that the MAC clause was triggered.[9] The decision concerned a target company, Akorn Inc. (“Akorn”), which was hit with unexpected competition and regulatory problems.[10] The Chancery Court wrote a 246-page opinion to justify the result that the acquirer, Fresenius Kabi AG (“Fresenius”), was allowed to terminate the agreement.[11]
Initially, Fresenius agreed to acquire Akorn for a total purchase price of $4.75 billion after the first quarter of 2017.[12] However, Akorn’s business performance “fell off a cliff” following the second quarter of 2017.[13] Although Akorn reassured Fresenius that the downturn was temporary, performance continued to decline, including a total change of -26% in revenue.[14] By November 2017, Fresenius decided that if they had a valid contractual basis, they would seek to terminate the Merger Agreement. Although the acquirer believed that the target’s “disastrous performance” should qualify as a MAE, their lawyers were not confident that they could prove that Akorn had suffered a MAE within the meaning of the Merger Agreement under Delaware law.[15]
Fresenius also received an anonymous letter that raised allegations about Akorn’s product development process, which also motivated the acquirer to terminate the agreement.[16] After numerous investigations and discussions, Akorn filed an action for specific performance of the merger agreement.[17] However, the Chancery Court held that the “sudden and sustained drop in Akorn’s business performance constituted a General MAE.”[18] Further, since Akorn made false representations about its compliance with applicable regulatory requirements, “Akorn’s as-represented condition and its actual condition would reasonably be expected to result in a Regulatory MAE.”[19] The Chancery Court concluded that the “magnitude of the inaccuracies” caused a collapse in Akorn’s financial performance that “could not be cured by the outside date in the contract.”[20] Thus, Fresenius validly terminated the merger agreement.[21]
Nonetheless, the Akorn decision was widely regarded as an anomaly.[22] Additionally, the Chancery Court reinstated that the “buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close.”[23] More importantly, “[a]short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror [sic].”[24] Therefore, ideally, when a buyer claims a MAE is triggered the buyer and seller should renegotiate.
Although there have not been many MAC lawsuits following the pandemic’s effects, LVMH’s purchase of Tiffany & Co. (“Tiffany”) and Sycamore Partners terminating their purchase of Victoria’s Secret from L Brands Inc. have received much attention.[25] Although on January 7th, 2021, LVMH announced that it has completed Tiffany’s acquisition, the road to acquisition included, renegotiation attempts, Covid-19 complications, and a trade war.[26] Starting in November 2019, the respective boards of LVMH and Tiffany signed off on what has been publicized as the largest deal to date in the luxury space.[27] LVMH, the largest luxury goods conglomerate in the world, was set to acquire Tiffany for $16.2 billion ($135 per Tiffany & Co. share).[28] However, although the two-well established names in luxury appeared to be “a really good match,” after the merger agreement was signed, the acquisition became a possible “deal-gone-wrong.”[29]
Like most M&A deals, the contract included a closing condition that there has been no material adverse change since the deal was signed.[30] However, the initial deal ran into trouble due to two exogenous conditions: the pandemic and the trade war.[31] Additionally, LVMH and Tiffany were both suffering from a decline in revenue, with Tiffany reporting a 44% percent drop in sales.[32] As a result, LVMH tried to back out of the deal claiming that the pandemic was a MAC.[33] Further, the acquirer based the decision off of a letter received from the French Foreign Affairs Minister, which addressed tariffs imposed on French goods by the Trump Administration. [34] In response, Tiffany filed a lawsuit seeking a court order to require LVMH to “abide by its contractual obligation under the merger agreement.”[35] In October 2020, after both parties received all of the necessary regulatory approvals required for the completion of the merger, LVMH and Tiffany began negotiating new terms for the deal.[36] The deal was back on track with LVMH set to acquire Tiffany for about 97% of the initial purchase price ($131.50 per Tiffany & Co. share).[37] Thus, the two exogenous events set the stage for renegotiation.[38] However, the renegotiation was still fairly favorable to Tiffany. First, although the purchase price fell, it was relatively small.[39] Second, Tiffany had a strong argument that there had been no MAC and the company itself did nothing wrong.[40]
Another deal that was set to take place in 2020 involved a private equity firm, Sycamore Partners, acquiring a majority stake in Victoria’s Secret.[41] However, the deal fell apart.[42] Initially, Sycamore Partners was interested in acquiring a 55% stake in Victoria’s Secret for $525 million after they valued the brand at $1.1 billion in February 2020.[43] However, due to the Coronavirus, Victoria’s Secret suffered “furloughs, sourcing interruptions, and mass store closures.”[44] Consequently, Sycamore filed a lawsuit arguing that L Brands’ response to the pandemic breached the contract.[45] Specifically, the buyer claimed that the target breached its agreement to run the business in the ordinary course and failed to meet the pre-conditions for the deal, triggering the MAE.[46] However, since Victoria’s Secret faced “an extremely challenging business environment,” the board of directors believed it was best not to engage “in costly and distracting litigation.” [47] Instead, they focused on navigating the environment to address the company’s challenges.[48]
Thus, in light of these circumstances, an important feature of contracts is to consider the conditions under which a party may walk away from the agreement.[49] More importantly, buyers, sellers, and lawyers must decide whether it is beneficial to have a range of precise or vague options in their contract design.[50] Some lawyers advise that “although limited, the existing case law on MAC clauses suggests that they should be drafted not only with specificity, but with quantifiable and easily determined monetary thresholds or descriptions of triggering events.”[51] This approach promotes deal-making because each party communicates what it wants to see in the contract.[52] Further, a lawyer’s reputation might suffer “if a vague provision gives rise to costly litigation and an adverse outcome for her client.”[53] In contrast, some argue that vague language can be beneficial because it can conceal matters that might ruin the deal if raised.[54] Moreover, if similar vagueness exists across agreements, greater precision might result in risks of its own.[55]
Most importantly, lawyers must decide what terms promote the goals of contract design.[56] For example, information problems are one of the main challenges of contract design.[57] Specifically, each party has private information that is not known by the other, hindering efficient exchange.[58] Additionally, M&A agreements need to address cooperative investment.[59] The contract must be designed so that the seller is motivated to invest in the company until the transfer.[60] Finally, contract design is complicated by uncertainty in exogenous conditions, including market forces, political developments, and pandemics.[61] Therefore, some scholars have advocated that vague language might be more beneficial.[62]
After 9/11 and the 2008 financial crisis, lawyers were “at the forefront of the effort to pick up the pieces from deals broken by the frozen credit markets and depressed economic conditions.”[63] Today, following the effects of the pandemic, lawyers face a similar role.[64] Some have observed that parties in litigation have not invoked MAE clauses in response to Covid-19.[65] Instead, they relied on other contract provisions because MAE “provisions typically don’t allow buyers to walk away based on changes in general economic conditions or broad declines in financial markets.” [66] Yet, others have noted that sellers should be even more extensive in identifying systematic risks.[67] For example, scholars have noted that post-Covid MACs have “tended to be a lot longer than pre-Covid MACs.” [68]
Therefore, whether MAC claims result in litigation or serve “as a tool for reopening negotiations over price,” it is important to consider what buyers, sellers, and lawyers can learn from the pandemic.[69] For example, “depending on the specific facts and circumstances, a particular company may . . . be more vulnerable to the effects of the pandemic . . . because of higher leverage; worse distribution, production, access to supply, intellectual property or goodwill; geography; or other factors.”[70] However, acquirers also have to consider whether the financial effects reflect a change in the long-term value of the company because “short-term hiccup[s]” will not suffice.[71] Finally, an important aspect of future deals will be to negotiate “the optimal mix of precise and vague provisions” when drafting the contract.[72] Thus, given the unprecedented effects of the pandemic, we should expect developments involving MAC analysis in contract design, renegotiation, and litigation.[73]
[1] See Andrew Schumacher & Brad Monk, What a Business Should Know Before Triggering a MAC Clause Based on COVID-19, Nat’l L. Rev. (Apr. 15, 2020), https://www.natlawreview.com/article/what-business-should-know-triggering-mac-clause-based-covid-19.
[2] See id.
[3] Albert Choi & George Triantis, Strategic Vagueness in Contract Design: The Case of Corporate Acquisitions, 119 Yale L.J. 848, 854 (2010).
[4] See id. at 853.
[5] Id. at 854.
[6] See id. at 848.
[7] See Alison Frankel, Sycamore Partners invokes MAE clause in bid to escape Victoria’s Secret deal, Reuters (Apr. 22, 2020, 5:21 PM), https://www.reuters.com/article/us-otc-mae-idUKKCN2243CK.
[8] See Stephen Bainbridge, Pondering how the material adverse effect clause of the LVMH-Tiffany merger agreement would have played out absent the settlement, Professor Bainbridge (Dec. 30, 2020, 2:27 PM), https://www.professorbainbridge.com/professorbainbridgecom/2020/12/the-lvmh-tiffany-settlement-is-a-classic-example-of-how-material-adverse-change-clauses-work.html.
[9] See id.
[10] See Frankel, supra note 7.
[11] Bainbridge, supra note 8.
[12] Akorn, Inc. v. Fresenius Kabi AG, No. 2018-0300-JTL, 2018 Del. Ch. LEXIS 325, at *46 (Del. Ch. Oct. 1, 2018), aff’d en banc, 198 A.3d 724 (Del. 2018).
[13] Id.
[14] See id. at *60.
[15] See id. at *63.
[16] See id. at *62.
[17] See id. at *1.
[18] Id. at *110.
[19] Id.
[20] See id. at *1.
[21] See id.
[22] See Frankel, supra note 7.
[23] See Akorn, 2018 Del. Ch. LEXIS 325, at *122.
[24] Id.
[25] See Eleanor Tyler & Grace Maral Burnett, ANALYSIS: Tiffany–LVMH Aside, M&A Party Lawsuits Are Outliers, Bloomberg L. (Sept. 17, 2020, 1:56 PM), https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-tiffany-lvmh-aside-m-a-party-lawsuits-are-outliers.
[26] See Tiffany & Co. v. LVMH: The Timeline Behind Luxury’s Biggest Deal to Date, The Fashion L. (Jan. 7, 2021) [hereinafter TFL], https://www.thefashionlaw.com/a-running-timeline-of-the-16-2-billion-tiffany-co-v-lvmh-battle/.
[27] See id.
[28] Id.
[29] See id.
[30] See Bainbridge, supra note 8.
[31] See Angelina Rascouet & Eric Pfanner, Tiffany Sues LVMH for Backing Out of $16 Billion Deal, Bloomberg (Sept. 9, 2020, 6:19 AM), https://www.bloomberg.com/news/articles/2020-09-09/lvmh-pulls-out-of-16-billion-tiffany-deal-citing-u-s-tariffs.
[32] See TFL, supra note 26.
[33] See Bainbridge, supra note 8.
[34] See id.
[35] See id.
[36] See id.
[37] Id.
[38] See Rascouet & Pfanner, supra note 31.
[39] See TFL, supra note 26.
[40] See Bainbridge, supra note 8.
[41] Áine Cain, Victoria’s Secret partnership with Sycamore Partners implodes after coronavirus, Bus. Insider (May 4, 2020, 7:21 PM), https://www.businessinsider.com/victorias-secret-partnership-with-sycamore-partners-implodes-2020-5.
[42] Id.
[43] Id.
[44] See id.
[45] See id.
[46] See Frankel, supra note 7.
[47] Cain, supra note 41.
[48] Id.
[49] See Choi, supra note 3, at 858.
[50] See id. at 856.
[51] Id. at 880.
[52] See id. at 884-85.
[53] Id. at 885.
[54] See id.
[55] See id.
[56] See id. at 856.
[57] See id.
[58] See id.
[59] See id. at 857.
[60] See id.
[61] See id.
[62] See id. at 858.
[63] Id. at 924.
[64] See id.
[65] See Frankel, supra note 7.
[66] See id.
[67] See Bainbridge, supra note 8.
[68] See id.
[69] See id.
[70] Gail Weinstein et al., COVID-19 As A Material Adverse Change In M&A Agreements, Law360 (Mar. 25, 2020, 1:02 PM), https://www.law360.com/articles/1256428/covid-19-as-a-material-adverse-change-in-m-a-agreements.
[71] See id.; See Akorn, Inc. v. Fresenius Kabi AG, No. 2018-0300-JTL, 2018 Del. Ch. LEXIS 325, at *122 (Del. Ch. Oct. 1, 2018), aff’d en banc, 198 A.3d 724 (Del. 2018).
[72] See Choi, supra note 3, at 924.
[73] See Weinstein, supra note 70.
